The Bogleheads' Guide to Investing
Are you a US citizen with a 401k? Or a UK citizen with a pension plan which you and your company contribute to? Or an Australian with a superannuation account? If so, you’re an investor, and you should consider reading this book. The book is targeted at a US audience but the principles remain the same around the world.
What’s with the title?
Jack Bogle is the founder of Vanguard Investments, a provider of no-load, low cost index funds and the first to provide these to individual investors. ‘Bogleheads’ are followers of the investment philosophies and strategies advocated by Jack Bogle. The book is authored by three Bogleheads: Taylor Larimore, Mel Lindauer and Michael LeBoeuf. The authors are all successful millionaire investors and are heavily involved on the Bogleheads forums, where they help investors to learn the Boglehead’s methods.
Although there is a connection with Vanguard, the book does not go over the top promoting financial products. Vanguard operates a wide variety of low-load, low-fee funds and is often quoted, but several other providers are also discussed. The advice contained within is therefore not motivated by sales commissions or pushing any product in particular. In fact, the authors suggest borrowing the book from the library!
The book is divided into two sections, and a number of chapters:
Section 1: Essentials of successful investing
- Choosing a sound financial lifestyle
- Start early and invest regularly
- Know what you’re buying (two chapters covering a wide range of investment vehicles)
- Preserve your buying power with inflation-protected bonds (aka inflation, the silent thief)
- Keeping investment costs low
- How much do you need to save?
- Keep it simple
- Asset allocation
- Costs matter (keep them low!)
- Taxes (two chapters mostly aimed at US audience but principles will apply worldwide)
- Diversification
- Performance chasing and market timing are hazardous to your wealth
- Savvy ways to invest for college
- How to manage a windfall successfully (not just lotto: inheritance!)
- Do you need an adviser?
Section 2: Follow through strategies to keep you on target
- Track your progress and rebalance when necessary
- Tune out the noise
- Mastering your investments means mastering your emotions (behavioural economics)
- Making your money last longer than you do
- Protect your assets by being well-insured
- Insurance
- Passing it on when you pass on
- You can do it
I will summarize three of the chapters which I thought contained especially useful information, but the entire book is easily accessible and worth reading.
Keep it Simple – make index funds the core, or all, of your portfolio (Chapter 7)
“Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees” – Warren Buffett (p.82)
The alternative to investing in individual stocks is to invest in mutual funds, where money from several investors is pooled together to buy a basket of stocks offering instant diversification. There are a wide variety of mutual funds, but they broadly fall into two groups:
- Actively managed funds, which are more expensive because fund managers are paid to pick stocks they think will win. Many of these funds claim to beat the market, but very few can do it consistently over the long term
- Passively managed funds such as index funds. These are automated or semi-automated (and hence low cost) to track an index such such as the S&P 500, the FTSE100, or the ASX All ordinaries.
According to a 2004 study by Dalbar Inc., from 1984 to 2002, the average annual return of the S&P 500 index was 12.2% p.a.. Over the same period the average equity mutual fund investor had an average 3.4% return p.a..
The authors explain that index investing has several advantages over actively managed funds:
- No sales commissions
- Low operating expenses
- Tax efficient
- No need to hire a money manager
- Highly diversified and therefore less risky
- Generally doesn’t matter who manages fund
- No problems with style drift and tracking errors
We cannot control our future returns, but we can control our costs. Index funds allow us to do this in the simplest manner.
The authors state that using index funds takes virtually no skill, time, effort or investment knowledge. While someone with excellent investment knowledge and experience may have a 20% of getting an A grade, investing in index funds will give you a 100% chance of getting a B grade.
The authors stress buying only index funds with annual expense ratios of less than 0.5% p.a., the cheaper the better.
The authors do believe that some actively managed funds are worthwhile, but that for majority of investors the bulk of portfolios should be held in index funds.
Asset Allocation (Chapter 8)
“The most important decision you will probably ever make concerns the balancing of asset categories… at different stages of your life” – Professor Burton Malkiel (p.106)
As well as keeping costs low, asset allocation is the most important element of your portfolio decisions. In this chapter the authors help the reader design their asset allocation plan.
Broadly speaking…
Assets can be broadly grouped into equities and bonds/cash. Equities tend to be higher risk but yield on average higher returns, whereas bonds/cash tend to be lower risk with lower, yet more predictable returns.
The authors explain that the mix of these asset classes in your portfolio will heavily depend on your time frame, investment goals, risk tolerance, and personal financial situation. For example, given the wide variance in the return of stocks, these typically are more suited to longer term investment time frames.
For retirement savings (which have long investment time frames), a good rule of thumb is that the percentage held in bonds/cash should be the same as your age, and the remainder in equities. Thus a young 20 year old with many years to retirement can withstand the swings of the stock market and hold a large portion of their assets in equities. Meanwhile the retiree who wants income stability should hold a large portion in bonds/cash.
In more detail…
The authors explain that for maximum diversification investors should think about how to subdivide their equity and bond/cash allocations. The good news is there are index funds available for most of these groupings allowing investors to keep costs low.
Equities cover both domestic and international stocks and shares, and are often split into groupings such as value/core/growth, large/medium/small capitalisation, or various market sectors e.g. health/technology/mining. The authors offer these considerations:
- A total index fund for your domestic market is ideal for most of the portion and will cover the broad groups of the stock market.
- Some investors like to be hold an additional index fund of value and/or small capitalisation stocks as these may result in less volatility and higher long term returns
- Sector funds can be avoided due to dangers of investment bubbles, and if held should not exceed 10% of the equity portion
- For most investors it will make sense to hold up to 20% of the equity portion in international stocks as domestic and foreign markets can behave differently. Broad based international index funds are available.
- Real Estate Investment Trusts (REITs) are sometimes considered separate from bonds. Since these behave differently to stocks, from a diversification perspective it can be worthwhile to hold up to 10% of equity portion in REITs.
Bonds and cash cover a wide range of investment vehicles as well. The authors offer these considerations:
- Opt for a broad based bond market index fund for the primary portion of your investment
- Avoid high-yield or junk bonds which promise a higher return, for higher risk. It is the stocks element of the investor portfolio which more efficiently serves this purpose.
- With a large portfolio, splitting the bond allocation between a ‘Total Bond Market Fund’ and an ‘Inflation Protected Security’ fund is a good idea from a diversification perspective.
Chapters three, four and five in the book give lengthy descriptions of each of these asset sub-classes as well as important considerations to take before investing in them.
Track your Progress and Rebalance when Necessary (Chapter 17)
Say an investor places 30% of their portfolio into bonds/cash, and the remaining 70% into equities. One year later, if the stock market has done really well, the portfolio might be 72% equities, 28% bonds/cash. To get this back to the plan of 30-70, the investor will need to sell some equities and buy bonds. If the stock market did poorly, split might be 67% equities and 33% bonds. To get this balance back to the plan of 30-70, the investor will need to sell bonds and buy equities. This is called rebalancing.
Why do this? The authors explain that the various money markets move every day. If the stock market has performed well, when investors rebalance they sell stocks while they are high. Conversely, if stocks have performed poorly, investors are buying them while they are low.
How often should investors rebalance? The authors point out that there may be cost considerations to take into account as buying and selling funds may involve transaction costs. Directing regular deposits or withdrawals to specific asset classes might be one way to reduce transaction costs. There may also be tax considerations.
Many people opt for yearly rebalancing, but some for quarterly or monthly. Other investors do not use regular time frames, but percentage bands for each asset (e.g. target stocks is 60% with 5% bands, so once the account gets to 66% it is rebalanced back to 60%). This method will require regular monitoring of the account.
A closing thought….
The internet has brought shares, bonds and other investments to the masses via online brokers.
“…most investors today are first-generation investors. They have no formal education about the subject and learned little or nothing about investing from parents, friends or relatives.” – Chapter 18, Tune out the Noise
This is true of us here at LLB and likely to be true for you too. This is one good reason to maintain a healthy scepticism of potential hidden sales agendas while researching and learning about investing.
Conclusion
The book provides the foundations required to build an adequate investment strategy, and I have found it useful in thinking about my own strategies. For those who choose the seek professional financial advice, using the knowledge gained from the book should enhance your dialogue with an adviser, by giving you background information on which to build a working relationship.
If you liked this summary, you should also read our summary of The Investor’s Manifesto by William Bernstein.
Important Note – this post is intended to be a book summary only and does not constitute financial advice. If you like the information presented here, I recommend reading the book as it goes into significantly more detail.